Forex Basics

Forex stands for foreign exchange or currency trading. The Forex market, or FX, is where all the currencies in the world are traded. It is totally decentralized (not based in any location). It is a gigantic market, the world’s biggest and most liquid by far. It is estimated that the average trading value every day exceeds $5 trillion. That is far more than all of the world’s stock markets added together. What all this means is that Forex trading presents some of the most exciting opportunities for trading that are simply not available in other instruments.

You have probably made Forex transactions before now without realizing it. Any time you have travelled to Europe, to the Eurozone countries, you have converted your pounds into Euros. The quantity of Euros you received was based on the current exchange rate between pounds and Euros at that point in time. Exchange rates are volatile and change constantly based on supply and demand as well as economic and political events.

The change in the exchange rate might not exceed more than one cent per pound from day to day, which seems negligible in itself. But consider far larger transactions than just your holiday money. Say a large company is buying or selling goods or services from abroad, possibly many hundreds of thousands worth. Then the small fluctuation takes on a far greater significance. Both you and the company may prefer to wait until the exchange rate is more favorable.

You can trade currencies I the same way you can trade stocks based on how you predict the price will move. With Forex, you can trade both ways - buys (up) and shorts (down). You would buy if you expect the value to rise. If you think it will fall, then you would sell. Take a scenario where the news reports about China say that they intend to devalue the currency so as to attract more foreign investment. If you believe that activity will continue, then you can back your judgement by entering into a Forex trade where you would sell the Chinese currency against some other currency such as USD.

How to make a trade?

Supposing you believe that the value of the Euro will rise against the dollar then the currency pair you would consider is EUR/USD. As the Euro is the first currency in the pair you would buy EUR/USD. If you thought that the reverse would happen and that the Euro’s value would fall against USD then you would sell the pair. Say the buy price for EUR/USD is 0.850614 with the sell price set at 0.850610 then the spread on your trade is 4 ticks (points). As the price moves, you start to make a profit (or loss) once it moves past the spread price. With Forex trades, the mechanics are that you are more or less borrowing the first currency to either buy or sell the second one in the pair.

Trading with leverage means you deposit, or allocate from your trading account balance, only the margin required for the size of trade you wish to make. Therefore, for 1:200 leverage you would need to allocate only £10 to fund a £2000 trade value. If you were trading at 1:50 then you would require £40 to fund that £2000 trade. Leveraging provides you with far greater exposure while minimizing your capital investment.

Leverage works both ways – it magnifies your profit when the price moves in your favor but also multiplies the losses when the price moves against you. That means your losses can be greater than the funds you have deposited in your trading account. Starting out in Forex, the sound advice is to trade only small amounts with lower leverage ratios. Once you have grasped the basics and are familiar with how it works then you can increase your investments.